What's fueling the car sales boom? Subprime loans
It's good news for the auto industry, but can mean bad things for credit-poor buyers.
This post comes from Lynn Mucken at MSN Money.
It turns out that the boom in new automobile sales -- up 11% in 2010 and even stronger so far this year -- is not being driven primarily by a reviving economy, a more optimistic population or even low prices. The cause, according to The New York Times is ... subprime lending.
But haven't all the lenders learned from their mistakes, and tucked their money into vaults before setting the time-release lock to "eternity"? As far as real estate, that perception is true, but America's auto industry has been successfully wooing the subprime borrower -- rotten credit scores, shaky employment history and low-paying jobs aside -- for months. Post continues after video.
The loosening of credit standards is a good thing short term for the badly wounded U.S. auto industry, and probably not a huge danger long term. Speculators don't "flip" cars, so there's no concern about a bursting bubble like the subprime-driven mortgage collapse that still haunts us.
On the other hand, car-buying can become a minefield for subprime buyers, those with FICO scores below 600.
AutoNation, a coast-to-coast network of more than 200 dealerships, told the Times that subprime customers made up 38% of its sales in the fourth quarter of 2010, compared with 18% a year earlier. The figure was close to 50% before the 2008 economic collapse.
Overall, more than 859,000 new cars were sold to subprime borrowers in 2010, a nearly 60% increase from the year before, according to CNW Marketing Research. Used-car sales experienced a similar leap.
If subprime buyers are bad risks, why are auto lenders courting them?
"Car dealers buy and sell money for profit," says Linda Goldberg, owner of auto brokerage firm CarQ, which arranges financing for clients as well as negotiating their car purchases. "Sometimes the financing profit can be three times the dealer's profit from selling the car," she told MoneyWatch.com.
AmeriCredit, a huge subprime auto lender that was purchased by General Motors in July, had an 8.3% loss rate in the period leading up to the sale, according to TheAtlantic.com. It made up for those losses by charging an average interest rate of about 17%; the interest rate approached 30% for some borrowers. The commonly advertised rate for better credit risks is 3.9%
"If you consider the math, it's pretty easy to see how you can make a profit by losing 8% if you charge 17%," wrote TheAtlantic.com. "AmeriCredit had a net income of 45 cents per share (before the sale to GM). That's with near 10% unemployment and many Americans continuing to struggle to pay their bills."
- Calculator: How much vehicle can you afford?
Another company working the subprime market hard is America's Car-Mart, which has 101 used-car dealerships, most of them in rural areas of the South and Southeast. According to CNN.com, in 2010 Car-Mart's credit losses as a percentage of sales averaged 22%, and its repossession rate was approximately 18%. Yet it had profits of $28 million on revenues of $339 million.
"Collections is the focus of our business -- selling cars is not," America's Car-Mart CEO Tilman J. Falgout III said in a 2002 interview.
Car-Mart keeps customers on a rigid schedule. If a payment is one day late, the customer receives a letter. After three days without payment, the customer receives a telephone call from Car-Mart. Vehicles are repossessed after 40 days without payment. "Substantially all incentive compensation is tied directly or indirectly to collection results," the company told CNN.com.
In addition to facing much higher interest rates, subprime buyers who have no other avenue for purchasing an automobile are willing to accept higher fees, come up with a down payment and even pay more than the vehicle's true market value. A subprime buyer quoted by The New York Times paid $19,000 for a 2008 Jeep Liberty that Edmunds.com estimated to be worth $13,577.
So what's a cash- and credit-poor customer to do? Check your FICO score yourself; it may be higher than you've been led to believe by the dealer. Remember that you're shopping not only for a car, but also financing, so check credit unions and banks and compare with what the dealership is offering. And temper your expectations -- you are not working from a position of strength.
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